Vendor financing is a loan arrangement that takes place between a company and a vendor that supplies a large amount of product to the company. This arrangement is different from extending a credit line, in that vendor financing involves the establishment of a specific amount that will be loaned, and with terms and conditions regarding the repayment of the loan within a specified period of time. This type of financing is not uncommon in situations where there is a strong working relationship between the customer and the vendor.
Vendors may choose to extend an offer of vendor financing as a means of increasing the sales of the company. The extension of the loan to a valued customer helps to make the bottom line look very good for the periods in which the loan amount is used to make purchases. At the same time, the financing will involve some type of interest rate on the loans. This means that the vendor also creates a revenue stream of interest income as well.
For the customer, the use of vendor financing may be a way to obtain products that are necessary to the operation, but are difficult to obtain due to current issues with cash flow. When this is the case, the offer of financing by a vendor is often very welcome. However, the customer should accept the offer only after investigating other means of funding the purchases. Vendor financing often involves a rate of interest that is higher than on most business loans. There is also the chance that going with this type of financing will increase the risk profile for the company, depending on the amount and terms of the loan.
In some cases, the vendor may choose to waive any type of payments on the outstanding balance of the vendor financing. Instead, the vendor may choose to accept an interest in the company instead. While this is rarely a controlling interest, it is important that the customer consider this option with great care before accepting the offer.